Stop Hyperventilating About Hyperdynamics

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Back in mid-December, I cited 101 reasons the market looks overheated. One of the examples I offered of a speculative stock showing signs of froth was Hyperdynamics (AMEX: HDY  ) , a small company with a large exploration license offshore Guinea. Amazingly, the stock has doubled since then.

Your first guess might be that Hyperdynamics made a huge discovery sometime in the past month. Well, that's not the case. The firm isn't planning to drill its first well until the fourth quarter. The only material news is that Hyperdynamics has entered into a letter of intent with a large independent E&P regarding a farm-out.

Farm-outs are pretty straightforward. A license holder sells down its interest in the exploration block to a partner who, in addition to possibly paying a signing bonus, agrees to foot a portion of future costs, as well as project-related costs incurred to date. Hyperdynamics brought in Dana Petroleum (since taken over by KNOC, Korea's national oil company) as a 23% partner about a year ago. It's now looking to farm out an additional 30% to one or more companies, in order to fund a three-well program expected to cost $129 million.

I should note that Hyperdynamics announced a letter of intent with Repsol (NYSE: REP  ) , which was to operate the project with a 37% interest, in late 2009. That deal was not completed. If the current negotiations fall through, I expect the shares to take a dive. But let's assume Hyperdynamics does bring in a strong partner like Noble Energy (NYSE: NBL  ) or Nexen (NYSE: NXY  ) to take the entire 30% farm-out. That leaves the company with its desired 47% interest and the ability to proceed with drilling.

How much is that barrel in the window?
Netherland, Sewell (NSAI), one of the top independent reserve estimating outfits, has placed a best estimate of 2.26 billion barrels of gross unrisked resource potential on Hyperdynamics' block. On the December conference call, management said that NSAI assigned the company a "risk-weighted resource estimate of about 350 million barrels." That translates to about a 20% chance of success on Hyperdynamics' 77% working interest pre-farm-out. If we use the same chance of success on Hyperdynamics' post-farm-out 47% working interest, that's 212 million net risked barrels.

With a touch over 125 million shares outstanding, Hyperdynamics' market capitalization is currently around $900 million. On an adjusted enterprise value basis, assuming the closing of the pending farm-out, I see the market valuing Hyperdynamics at roughly $4 per risked barrel.

$4 per barrel? Sign me up!
That might not sound like much, compared to an international oil price flirting with the $100 level. An oil barrel in hand is worth a heck of a lot more than two in the possible bush, however. Four dollars is on the high side for undiscovered oil barrels in a virtually undrilled frontier province. I used a $5-per-risked-barrel metric for my valuation exercise on Cobalt International Energy (NYSE: CIE  ) last year, but that company focused on the Gulf of Mexico, Angola, and Gabon. Unlike those well-developed oil markets, Guinea has not seen any modern offshore drilling, and I assume it has little to no relevant infrastructure.

I'm not questioning the prospectivity of offshore Guinea. Anadarko Petroleum (NYSE: APC  ) made a discovery in neighboring Sierra Leone in its first attempt. Further up the coast in Mauritania, there have been a string of discoveries as well. I do think Hyperdynamics should get a larger frontier risk discount than investors are currently awarding it, however.

An attempt at an apples-to-apples comparison
Consider Chariot Oil & Gas, a U.K.-listed company with major acreage offshore Namibia. Namibia, another virtually unexplored oil frontier, is just south of OPEC member Angola, and smart folks such as HRT Oil & Gas' Marcio Mello (formerly of Petrobras (NYSE: PBR  ) ) argue that it's analogous to offshore Brazil and its massive pre-salt oil deposits. It would seem that Namibia is at least as prospective as Guinea.

Chariot has brought in Petrobras as a 50% partner on part of its acreage. Looking at only the portion covered by that farm-out, and assuming the same 20% chance of success as with Hyperdynamics, Chariot is valued at around $0.80 per net risked barrel. These guys use NSAI to do their reserve estimates as well, though this week's resource update has not yet been independently verified.

Chariot doesn't have much money, and it also has no drilling timetable, so I would expect it to trade at a fairly hefty discount to Hyperdynamics. Still, the valuation gap is pretty striking. Is Hyperdynamics really worth five times as much? As always, I encourage you to sound off in the comments section below.

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Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profile or follow his articles using Twitter or RSS. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (16) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 15, 2011, at 1:20 AM, royaliowa wrote:

    You sound like a guy who you or your family member just shorted the stock, of course right before you posted your item.

    you have no research or anything to base your opinion on except of course maybe a wish to bring down the pps of this stock.

  • Report this Comment On January 15, 2011, at 8:19 AM, mauzie wrote:

    Interesting article. A lot of risk, here but if the world did not embark on risk we would all still be living in caves. Have been in and out of this company for eyars. There will be further weakening in the coming months as fourth Q is a ways off.

  • Report this Comment On January 15, 2011, at 9:36 AM, ggdg wrote:

    Perhaps the rise in shareprice is due to a few other things besides the LOI. Here are a few things to consider as well:

    1) The 3D seismic survey was completed at the end of 2010. Real time data has been coming in thru out the process (i.e. the company has a good idea how good the 3D is). NSAI will be doing a revised report in the coming months considering the 3D data that should significantly reduce the risk-weighted resource estimate.

    2) The LOI you reference was signed after the 3D was substantially done. The potential partner signed for exclusive rights to negotiate until Jan 27th. They were privy to the streaming 3D data. Assumption: they like what they saw!

    3) Blackrock made a significant investment in HDY this fall. Perhaps many funds who follow on Blackrock's coatails were freed up to jump in once HDY hit $5 - propelling us even higher.

  • Report this Comment On January 15, 2011, at 9:46 AM, ggdg wrote:

    forgot a few :

    4) the NSAI estimate of 2.3B is only on a small portion of the concession. The are many other prospects that will be covered in the next seismic survey - one covering a potential supergiant structure.

    5) have you looked into the management team that the CEO, Mr. Ray Leonard, has put together. HDY may be a small little start up, but there is nothing small or "start-up" about Mr. Leonard (who's resume is beyond impressive) or the team of people he has surrounded himself with. Here's a link to their website. Take a look at the resume of management, the BOD members, as well news releases discussing those hired over the past 6 months. Quite impressive.

  • Report this Comment On January 15, 2011, at 10:06 AM, ggdg wrote:

    revision to point #1:

    I meant to say that the revised NSAI report given the inclusion of 3D data should significantly increase the the risk-weighted resource estimate.

  • Report this Comment On January 15, 2011, at 1:15 PM, Lomax9 wrote:

    Your comments are both silly and stupid for this late in the game. Where were you when I purchased this stock at .89 cents a share? Sleepin'? If you don't like this stock..then jump ship..theres the rail.


  • Report this Comment On January 15, 2011, at 1:54 PM, HDYFAN wrote:

    Once again Motley Fools is bearish on HDY's valuation. I find this humorous after the past comments failed to stop HDY's big rally. Short sellers from under $4 must be irritated!

    This time, MF has dug in a tiny bit more into HDY and has published an opinion as the stock is at mult-year highs, again. Clearly the stock is due for some consolidation based on a technical analysis view. However, HDY has left many TA based traders in the dust by running like a horse again and again. This horse may just march on up as investors privvy to the 3D results may be buying everything they want, up to some target price higher?

    The bottom line here is that HDY is NOT about 400 million barrels of oil. It never was and HDY's highly respected ceo is playing to win. HDY is about many BILLIONS of barrels of oil and mind boggling potential for natural gas, gas that is so close to the world's leading bauxite production/reserves. HDY is also a potential nation builder for Guinea. It's so much more than a measily 400M barrels of oil.

    While $900 million in market cap might seem rich to some, I bet a national oil company in China would be happy to pay $2 Billion or more now for the concession IF HDY would sell it for that. Does that make HDY a bargain at $7.50?

    Does the average person betting against HDY have an idea of what each billion barrels of proven reserves is worth to HDY? Do these people realize how many oil seeps there are and that oil is visible from satelite images. Ray Leonard doesn't call the concession an "OIL PROVINCE" without highly respected credibility.

    If one billion barrels of oil is worth roughly $40 per share in reserves only valuation, suppose HDY drills three different targets later this year and odds favor he hits commercially viable hydrocarbons in at least one location, what's HDY worth per share as investors wait for proven reserves numbers? In addition, HDY has a lot of area to do more 3D work, those areas will likely yield many more targets and at least one super giant target in my opinion.

    There are many of us who have 5 and 6 figure holdings of HDY at zero or nominal cost basis from buying and trading it when it was insanely undervalued, as we've been following the story closely for many years. Nobody is getting our shares any time soon, many of us are waiting to see what the drill bits prove. Wildcatting at it's very best is HDY now. Ray Leonard is holding. We will hold.

    People are hyperventilating because HDY could be way bigger than UPL was off it's lows to it's highs. It's tough to find a more interesting speculation than HDY.

    Don't be a fool and miss out on HDY! Perhaps the most foolish thing a person could do is not hold some HDY long term? Good luck and speculate cautiously!!

  • Report this Comment On January 15, 2011, at 2:08 PM, HDYFAN wrote:

    As ggdg pointed out, 2.3 Billion barrels estimated is very conservative AND it's for only a sliver of a very large and highly prosecive area.

    We could use a professional geologists view here, but I plan to be long HDY if and when they've proven over 5 billion barrels. Assuming the company is not merged or taken over, and assuming oil prices are way higher in the future, without any production, and on proven reserves valuation alone, HDY could be $100's of dollars per share. That's the potential upside...easy to see, Downside is only 100% for non margined players. Downside for us oldtime HDY fans is nominal relative to the upside, and it's been quite a trip the past seven years.

  • Report this Comment On January 15, 2011, at 2:57 PM, camcorp1 wrote:

    Twelve Steps to Big Oil

    1) New Management which consists of True Oil Men. The CEO & many of the VPs quit their high paying Jobs to take on this challenge. What I like best is the management team has a plan and executing that plan with precision. The CEO, Ray Leonard has consistently under promised and over delivered. The management operates in a mode of transparency & integrity. There are business updates every two months which are broadcast online so that all shareholders and potential shareholders can listen in.

    2) Signed a contract with DANA oil company. DANA is UK exploration company which bought into 27% of the concession. Dana has since then been taken over by KNOC (Korean National Oil Company). KNOC has $Billions to spend on oil for their country (South Korea).

    3) $15 million endorsement by Blackrock, one of the world’s most respected Financiers. It's bigger than JP Morgan. Blackrock bought in at $2.00 per share & now enjoys more than a triple at $7.00 per share.

    4) Assessment of 2.3 Billion Barrels of oil in only a fractional portion of the Concession. The assessment was done by Netherland & Sewell. This company is frequently hired by major oil companies to interpret their seismic data.

    5) First Democratic elections in the Republic of Guinea since 1954 (or something like that).

    This represents some type of stability in a country that’s been plagued by rioting, poverty, deception, corruption, etc.

    6) Recently signed a Letter of Intent (LOI) with a Major Independent Oil Company to become a Joint Venture partner in the concession. This is important because the capital for drilling cost would now be shared by the JV partner, KNOC & HDY. There are even rumors that the JV partner may absorb all of HDYs portion of drilling costs due to the potential size of the future discoveries. HDY has given this new potential JV partner exclusive rights to study the 3D data and basically closed its data room to all other suitors.

    7) Completion of the 3D seismic in the fourth quarter of 2010 on the shallow water portion of the concession. The seismic data should be completely interpreted by the end of January. Note that 3D seismic will provide a more detailed view of the potential oil below.

    8) The announcement of a 'HDY friendly' Minister of Mines. This is the person that deals with foreign companies regarding the natural resources of the Republic of Guinea.

    9) Rumors of a Supergiant field in the deep water portion of the Concession. This has always generated the most excitement for the concession. HDY has chosen to drill the shallow waters first due to early capital restraints & wanting to achieve an early success.

    10) Major oil discoveries have been made in neighboring countries offshore concessions above & below the Republic of Guinea. Some of the smaller companies involved in the discoveries have been offerered billions of dollars by major oil companies like Exxon & government owned oil companies like CNOOC (China National Offshore Oil Corporation). These companies have deep pockets & are willing to pay whatever amount is necessary to explore for oil in the West African Oil Province.

    11) Institutional Ownership of the stock is low. Once major institutions (mutual funds, retirement funds, brokerage houses, etc.) start to purchase this stock then the number of available shares will be in short supply because Institutions Buy & Hold. Basic economics 101 of Supply & Demand (Low Supply, High Demand = Higher price).

    12) Short Interest is high. Shorts are folks that bet the stock price will drop. This is important because when the Institutions start to purchase the stock in large blocks; the Shorts will have to cover. When the price continues to rise as it has over the past few months then the Shorts must purchase the stock to cover or risk Financial Devastation.

    Note: The current contract with the Republic of Guinea states that HDY must spud a well by December 31st of 2011. That means the truth (oil or no oil) will be known in short order. If the 2.3 Billion barrels of oil exists then the People of Guinea & Shareholders will be rewarded in an exponential way.

    ** Major announcements are due out in the next few weeks **

    More information can be found on Hyperdynamics website at

    Especially check out the NSAI report, the conference calls, and the FAQs.

  • Report this Comment On January 15, 2011, at 3:52 PM, 789789789 wrote:

    Hyperdynamics concession is 9650 sq miles equivalent to 6,176,000 acres. At today's market cap that comes to approx $141.00 per acre.

    April 2010 - Texas leased 1,280 acres for offshore drilling to VHGI at $400.00 per acre

    Add to that the excellent relationship Mr. Leonard has with the government of Guinea and you have the formula for a long, healthy business relationship.

    BTW ... I know its a different animal but do you see what companies are paying for USA shale play acreage? Average - $2000.00

  • Report this Comment On January 15, 2011, at 4:52 PM, royaliowa wrote:

    Some very good insight by many people who have a good interest in this stock. There is no reason for this stock to be 25 cents and there isn't a real reason for it to be 10.00. Lack of confidence drove it down, real confidence on having such a possibility along with having a board of Oil men now running this company who has made so many gains towards showing positive results is beginning to pay off.

    HDY is not valuable for what it has accomplished as much as for what is possible, and if you want to buy this stock when it's proven it won't be for 8.00 a share, it will be more around the 16.00 a share and rising.

    I'll hold and wait for the big side, and if it comes sooner than later i will be very happy, but i am betting it is still on the way.

  • Report this Comment On January 15, 2011, at 6:18 PM, brchad wrote:

    camcorp1 lines it out in a much more professional way than the author of the Fool article does!!!

    It would appear that Toby may want to limit his analysis to the fashion industry. The oil business is just way too "sticky" for him.

  • Report this Comment On January 16, 2011, at 1:16 AM, paultaut wrote:

    This is the definition of a Farmout:

    contractual agreement with an owner who holds a working interest in an oil and gas lease to assign all or part of that interest to another party in exchange for fulfilling contractually specified conditions. The farmout agreement often stipulates that the other party must drill a well to a certain depth, at a specified location, within a certain time frame; furthermore, the well typically must be completed as a commercial producer to earn an assignment. The assignor of the interest usually reserves a specified overriding royalty interest, with the option to convert the overriding royalty interest to a specified working interest upon payout of drilling and production expenses, otherwise known as a back-in after payout (BIAPO).

    It differs Slightly from your concept.

  • Report this Comment On January 16, 2011, at 12:51 PM, Observer10 wrote:

    I noticed that you recommended shorting this stock at less than half the value it is at now. You waited for a down day to put this out so as to add to the selling in hopes of not looking like such clueless asses. I'm betting that once again you will look like the fools that you are and this stock will be over $8 by 1/21/11. HDY has fantastic management and fantastic potential. Smart people do their own research then buy and hold!

  • Report this Comment On January 16, 2011, at 3:04 PM, HDYFAN wrote:

    Some HDY shareholders view the Motley Fool piece as hatchet work to serve the short sellers who are losing a lot of money IF they believed past bearish pieces about HDY from these and other journalists.

    Before more investors/traders risk getting tossed to the sidelines trying to trade HDY or sell it short, they should consider the experience and reach of HDY's board of directors. Vast political connections exist. Oil is a matter of security and it would also be wise for MF readers to gain some understanding of US military efforts on the W. Coast of Africa. Why?

    The powers that be are watching in my opinion. Guinea will not be a third world country forever. I hope the money to come does not turn into a curse for them. Of course I'm assuming the oil is there. We know it's there, we just need to quantify it, prove it to SEC standards.

    Guinea, a democracy in it's infancy is the basis of the HDY "story"/business plan. Conakry could become the NYC of West Africa in a few decades. Clearly the world is changing and wealth will build where the resources exist.

    Many millions of lives can be impacted by HDY's years of hard work. I wish them the best and hope to see the trickle down effect to the poorest Guineans. The former CEO and founder of HDY set up American Friends of Guinea. The many shares of stock donated by the Watts family to that charity could have a vast impact on the people there. Smaller projects have already had positive impact.

    Soon, within days, we should see which company is HDY's next JV partner, perhaps the final one. I hope to see HDY next drill and prove many millions or BILLIONs of barrels on the first series of wells, ideally keeping the shares outstanding where it is until reserves are proven.

    I believe that Blackrock's due dilligence and investment trumps everyones and I strongly suspect that Blackrock has HDY's back if terms aren't nailed down by the Jan. 27th deadline. Blackrock wants to see HDY grow into a serious energy company in my opinion. I believe Blackrock will insure HDY remains the operator of this "oil province". Blackrock got in early and at low cost, looking for MAGNITUDES higher. Leverage has changed and investors who don't get the big picture should think more. Think and Grow Rich.

    Lastly, MF readers should study Ray Leonard's incentive plan. At around $9 per share, Ray gets his biggest allotment of warrants, which should roughly double his holdings. Anyone who's taken the time to get to know about Ray Leonard, realizes he simply doesn't and hasn't failed since coming to HDY. Wise money should be betting Ray gets his shares. He deserves them.

    All the best from Beavercreek Ohio.

  • Report this Comment On January 16, 2011, at 3:47 PM, camcorp1 wrote:

    Revision to Step 3 on my previous post.

    It should read as follows:

    3) $ 30 million endorsement by Blackrock, one of the world’s most respected Financiers. It's bigger than JP Morgan. Blackrock bought into 12% of HDY at $2.00 per share & now enjoys more than a triple at $7.00 per share.

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